Commercial intelligence analysts Wood Mackenzie forecast an upturn in upstream oil and gas in 2017. In our latest Global Upstream Outlook, we say that 2017 will demonstrate how efficient the oil and gas industry has become; showing projects in better shape all round.

According to the report, Five things to look for in 2017, the investment cycle will show the first signs of growth since 2014 and final investment decisions (FIDs) will double, compared with 2016. Confidence will start to return to the sector, with exploration and production spend set to rise by three per cent to US$450 billion.

Though a corner is being turned, this is still 40 per cent below the heady days of 2014. At the forefront of the revival will be US tight oil (light crude found in shale or sandstone, also known as shale oil). Costs will continue to fall in 2017, though only marginally. But for all the pain of the downturn, a leaner industry is starting to emerge.

Capex deflation has averaged 20 per cent over the past two years. With service sector margins wafer thin, Wood Mackenzie believes there’s now only room for small reductions and capital costs are expected to fall by an average of three to seven per cent

The key themes of the report are:

• Global investment will rise, reversing two years of severe decline.
• FIDs will double and deep water is back on the agenda.
• Costs will bottom out as an efficiency boom takes hold, but more work is required.
• Fiscal rules need to improve to attract scarce investment.

Rise in global investment

The global investment cycle will show the first signs of growth in 2017, bringing the crushing two-year investment slump to a close.

US tight oil, and the Permian basin in particular, will lead the way, distinguished by low breakevens, scale and flexibility. US Lower 48 spend is set to grow by 23 per cent, to US$61 billion, with upside if oil prices rise strongly and US Independents are emboldened by a Trump presidency.

FIDs to double

Wood Mackenzie predicts the number of FIDs will rise to more than 20 in 2017, compared with nine in 2016. This is still well short of the 2010-2014 average of 40 a year. But these are generally smaller, more efficient projects, and capex per barrel of oil equivalent (boe) averages just US$7 per barrel, down from US$17 per barrel for the 2014 projects.

Companies will get more bang for their buck as development incremental internal rates of return (IRR) will jump from 9 per cent to 16 per cent, comparing 2014 to 2017. This is in part a result of a shift in capital allocation away from complex mega projects towards smaller, incremental projects in the Canadian oil sands and deep water.

A leaner industry

Nowhere is the mantra ‘doing more with less’ more evident than onshore US. There has been a dramatic increase in efficiency in the sector, exemplified by the drillers, who are managing to complete wells up to 30 per cent quicker.

However, as the tight oil sector heats up further, the spectre of cost inflation looms in 2017. But any increase in costs may well be offset by further efficiency gains in earlier-life plays. For example, there’s still potential for a further improvement in drilling speed of 20 per cent to 30 per cent in some early-life tight oil plays.

Deep water will spring back to life in 2017, but more cost cutting is needed in the long run
Deepwater FIDs will be a leading indicator the tide is turning. The best development assets will hold their own against tight oil, especially as more risk-averse tight oil operators start to screen opportunities under higher discount rates.

Projects slated for FID in 2017 are largely looking good, but the longer-term deepwater pipeline is more challenged. Of the 40 larger pre-FID deepwater projects, around half fail to hit 15 per cent IRR at US$60 a barrel.

The industry has selected the best projects to optimise and take forward. In 2017 it will have to turn its attention towards optimising the next wave of developments to get them sanction-ready.

Fiscal terms will need to improve

Graham Kellas, senior vice president of global fiscal research at Wood Mackenzie, adds: "Some governments will be tempted to increase tax rates, but those with uncompetitive fiscal regimes will have to make changes to ensure they can attract still-scarce new capital. Getting the risk-reward balance right will be a critical factor in attracting scarce investment capture in 2017, even for resource-rich hotspots such as Iran and Mexico."